Peter Carey wrote a short book in 2005 about his travels with his son. The book called, Wrong about Japan, was a series of anecdotes forming a cultural study of modern Japan. I have been thinking that one story seems particularly pertinent to today in reference to the current relationship to US labour and capital growth.

Strength and flexibility

Carey and his son visited a samurai sword maker and marvelled at the skill of the artisan and the strength and flexibility of the sword. Its strength comes from two hard pieces of steel that constitute its outer shell, while its flexibility comes from a core of soft molten steel. Such a design gives the sword considerable power. Carey notes gruesomely, that the test of a samurai sword was to chop a man from the neck to opposite armpit in once blow.

Metaphor for economy

In a way, the sword is an interesting metaphor for an economy. The exterior is the infrastructure, both physical and institutional, that must act as the base – the strength of an economy. The core is the population, the labour force. Like a good sword, a good economy is a balance of strong physical and institutional infrastructure that in many ways must be considered indestructible with a flexible, adaptable labour force.

Widening political divide

Such a description may have been apt for the United States. The highway system, built under Eisenhower, is an example of the strength while the workforce proved to be both adaptable and flexible, prepared to go where the jobs were and learn new skills. But increasingly, it seems the US economy is weakening. Its infrastructure is chipped and its institutions suddenly seem less capable, or perhaps, less worthy of respect. Most problematically, the population seems to be hardening into divided factions; a combination of high long-term unemployment and a widening political divide.

The emergence of this hardening seems to have a lot to do with changing distribution of income in the US economy. In the course of the last ten years corporations have taken a greater and greater share of US GDP, at the expense of households and the government. Corporate earnings as a share of GDP have risen to 10 per cent from as little as 3 per cent in 1986. The share to wages has correspondingly fallen to 56 per cent from 60 per cent.

Capitalism’s crisis

This is capitalism’s crisis; corporations are making money at the expense of the people they employ.  So, is it politics or economics that changes the allocation?  I believe economics provides the best answer but the longer corporations take to change  the more likely a political response is used. While there is no golden ratio for sharing income across an economy, there are relationships between capital, labour and government that provide some insight into what drives the relative shares.

The Laffer curve

The relationship between government and capital and labour is summarised in the Laffer curve. This curve suggests that at a tax rate of 0 per cent and 100 per cent, no tax revenue will be raised. Unfortunately, because governments, generally, don’t believe in experimentation with tax rates, we don’t know with any accuracy what the rest of the curve looks like. Broadly, however, it would make sense that as tax rates rise beyond a certain point the incentives to work fall to a point where the tax collected is lower than that collected at a lower rate of tax.

The data clearly suggests room for better tax policy, but the focus of this blog is on the relationship between capital and labour which is the core of a market economy/liberal democracy.

Age old battle

Capital and labour need to exist in rough proportion to each other. Despite, the seemingly age-old battle between capital and labour, capital can’t exist without labour and vice versa. An excess supply of labour to capital means labour is less productive and, relatively, receives a lower income and vice versa.

The data suggest that relative to other economies, in this case China and Australia, the US has under-invested. Furthermore, a large share of the investment in the last 20 years has been residential. This suggests that spending on capital goods by industry in the US is probably not that far above depreciation.

Real productivity improvement?

There are of course a number of valid reasons for this. First, the US starts with a much higher base with some estimates suggesting the Chinese capital stock is just one tenth the US capital stock on a per capita basis. Second, technology means that replacement of capital can still greatly add to productivity; a typewriter is replaced by a PC which in turn is replaced by a laptop, and so on. Third, there have been some positive blips in the trend, particularly the investment in the dot-com bubble which, though over-priced, has led to real productivity improvement.

Capital growth not coping with labour growth

An alternative proof to this hypothesis should be found in the labour market. A lack of investment in capital would make labour less productive and lead to lower wages and a lower demand for labour. Clearly, income to labour is shrinking. As for labour demand, since 1999, the American population has risen 10 per cent or 29 million people. Yet, there are 600,000 fewer Americans employed today than there were in 1999 (Australia employs 2.5 million more people than it did in 1999) while the number of people in the labour force has risen by 13 million, it’s been flat since 2008. American businesses are not creating the capital to cope with labour force growth.

Capital-lite

Now, it could be argued that modern technology makes labour redundant and that the lack of capital creation is a function of this. But I tend to think it’s a function of incentives. First, equity markets tend not to reward companies who launch large capital expenditure programs, particularly in the wake of the dotcom crash. Second, when all owners of capital behave in a similarly capital-lite way there is an increasingly higher pay-off. Effectively, capital becomes more and more scarce and so the return on capital must rise. Cost-cutting, one of the drivers of US corporate profitability and asset prices, can be thought of as the mechanism by which this occurs. As a firm fires labour there’s more income for share-holders, and therefore, capital.

This is all reminiscent of the poem, The Rime of the Ancient Mariner by Samuel Taylor Coleridge:

“Water, water everywhere, Nor any drop to drink.”

In a world where interest rates are at historic lows, signalling abundant financial capital, it would seem perverse that the developed world is not enjoying a boom in capital investment so as to absorb the equally abundant labour. Part of the answer may lie in offering greater incentives to invest. But more likely the answer lies in the government assuming this role and building the infrastructure a good economy may need.

The challenge

This is the challenge for US politicians. To revitalise the sword of the US economy requires the revitalisation of US companies from cost-cutters to investment drivers or alternatively for the Federal government to take on the challenge. The strength of the US sword will be dependent upon this.